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Tuesday, January 29, 2008

Ilargi: Spain is blowing up, and has been doing so under the radar for quite a while. This will reveal the Achilles' heel in the Euro zone: the weakest link in the chain and all that. Europe starts to unravel, and there's what, 27?, countries aligned like so many domino stones.

Also, read the whole CNN/Fortune story on CountryDied, and observe the snide remarks. They would have been impossible until very recently. A THIRD of its subprime loans are delinquent. And then the share price goes up, after BoA says again that the takeover is on. Yes, second half of 2008. HA!!!! That deal was stillborn, it's a PR trick.

Spanish banks are issuing mortgage securities and asset-backed bonds on a massive scale to park at the European Central Bank, using them as collateral to raise money at favourable rates from the official credit window in Frankfurt.

The rating agency Moody's said lenders had issued a record €53bn (£39bn) in the fourth quarter, yet almost none of the securities have actually been placed on the open market. Most have been sent directly to the ECB for use in "repo" operations. "The market has shut down," said Sandie Arlene Fernandez, the author of the report.

"Few, if any, of the transactions in the RBMS market (mortgage securities) have been placed since September. Some of the banks are hoping that the market will open up again but most are just preparing these deals to use as repos, which they can do since the ECB accepts AAA-rated securities," she said. The total volume of securities issued since the credit crunch began to bite in July has reached €63bn.

Reliance on the ECB window appears to have kept the mortgage sector afloat despite the sharp slowdown in the Spanish property market and the de facto closure of the capital markets for this type of business, allowing Spain to avoid the sort of mishap suffered by Northern Rock in Britain and Countrywide in the US.

Countrywide on Tuesday reported a loss of $422 million in the fourth quarter and revealed that an astounding one-third of its investment portfolio's sub-prime mortgage loans are delinquent.

The loss threw cold water on Countrywide chief operating officer Steve Sambol's confident assurances to investors in October that, "We view the third quarter of 2007 as an earnings trough, and anticipate that the company will be profitable in the fourth quarter and in 2008." Seen in this light, Countrywide's fourth-quarter loss, compared to a $621 million profit a year ago, is what the numerous class action attorneys circling Countrywide will surely call "an unfavorable fact." Countywide finished 2007 with a loss of $704 million.

The numbers didn't appear to faze Bank of America CEO Ken Lewis's determination to acquire Countrywide, however. In a conference Tuesday, Bloomberg quoted him as telling investors. "Everything is a 'go' to complete this transaction." Just over two weeks ago, BoA agreed to buy Calabasas, Calif.-based Countrywide in a $4 billion deal. If and when the deal goes through, the combined company will control just over 25 percent of the U.S. real estate loan origination market.

The market took the highly scripted BoA support as crucial and sent Countrywide stock up 20 cents to $6.15. At the fulcrum of the mortgage credit crisis, Countrywide's earnings are seen as a bellwether for the once vibrant - and now largely collapsed - United States mortgage industry. The primary culprit remains a combination of old-fashioned credit deterioration plus an alarming new development: Borrowers simply are walking away from their homes as their equity value falls ever further below their loan amount.

Ilargi: Bloomberg has further developments in the SocGen case (thanks, webjazz). Ummm, this is starting to smell like some French cheeses. If you're on the board of a bank in France, and you ditch $200+ million in shares right before a revelation like this, you’re French toast. Which, of course, goes well with the cheese. The last article in this post states that Citigroup "cut its [SocGen] target price from €130 per share to €65, reducing its market price tag from €72.9 billion to €36.4 billion." So Mr. Day saved himself $100 million, but the Elysée will look at what this cost the French.

Societe Generale SA board member Robert Day and his foundations sold shares of the bank worth 45 million euros ($67 million) on Jan. 18, the day it said management discovered trading frauds costing 4.9 billion euros. Day's sales totaled 40.5 million euros for himself and 4.5 million euros for the Robert A. Day Foundation, France's market regulator, the Autorite des Marches Financiers, said in two statements on its Web site.

These sales bring to 140 million euros the amount of shares in Societe Generale that Day or his foundations have sold since the start of the month. "The AMF has opened an investigation into Societe Generale," Christine Anglade, a spokeswoman for the regulator, said today. She declined to say what the AMF was looking into at the bank.

Ilargi: The new revelations about what really happened with Countrywide and Bank of America are a perfect starting point to send out a warning, and an explanation.

Countrywide contacted BoA after issues arose over the 'Advances' (borrowings) it obtained from the Federal Home Loan Banks (FHLB) system. CFC was theatening to break through the ceiling of what it could borrow from the Atlanta FHLB. At a certain point it had over $51 billion in advances.

Legislation provides the Federal Home Loan Banks with a "SUPER LIEN" on any bank assets if a member bank fails. This means the FDIC may not have enough funds to pay depositors after the FHLB Advances have been paid.

The FHLB is a GSE, a government sponsored entity, like Fannie Mae and Freddie Mac, private but 'covered'. The FHLB has never lost a penny on defaulting loans. When a bank goes tummy-up, its Super Lien gives it first rights to whatever of value is left.

Through her research, she advised, she was fascinated to learn about the FHLBs' "super lien" against the assets of banks to which they make advances. These rights, she added, including prepayment fees, are provided by statute and are superior to the rights of depositors and even to the FDIC after an institution fails.

In general, people expect the FDIC to guarantee the first $100.000 in deposits for every account. But the FDIC insures the banks, not the depositors. In other words, depositors will have to hope something will be left after the FHLB have taken back their loans. In case of a large numbers of defaulting banks, we are looking at hundreds of billions. And it's questionable if the FDIC will have enough left to pay to depositors. Knowledgable TickerForum poster Karen 'Nothing':

The depositors will have to get in line behind the FHLB to negotiate with the bank to get their "insured" deposits back.

This does not necessarily mean that no-one will get back a penny if their bank fails, for one thing nothing like a large scale bank failure has happened in a long time, but it does make clear that the situation is much more complicated than most people think.

The fear of potential regulatory crackdowns helped drive Countrywide Financial Corp. into the arms of acquirer Bank of America Corp., people familiar with the situation say.

Though the big home-mortgage lender faced large and unpredictable losses on defaults, the more immediate danger was pressure from regulators, politicians and rating firms, these people say. That realization helped spur Countrywide co-founder and Chief Executive Angelo Mozilo to call Bank of America in December and start talks that led to the Charlotte, N.C., bank's $4 billion deal to acquire Countrywide, which was announced Jan. 11.Countrywide, due to report fourth-quarter results today, faced "a cascading series of regulatory issues" as it pondered whether to try to stay independent, says one person briefed on the situation. A Countrywide spokeswoman declined to comment.

After falling home prices and mounting mortgage defaults rattled investors in mid-2007, Countrywide could no longer raise money through short-term borrowings in the capital markets or sales of mortgages other than those that could be guaranteed by government-sponsored investors Fannie Mae and Freddie Mac. That forced Countrywide to rely much more heavily on two other sources of funding: deposits at its savings-bank unit and borrowings -- so-called advances -- from the Federal Home Loan Banks system. But the sustainability of those funding sources was increasingly in doubt by late last year.

In late November, Sen. Charles Schumer, a New York Democrat, wrote to regulators of the 12 regional Federal Home Loan Banks, cooperatives that lend money to banks and other financial institutions. Mr. Schumer argued that a surge in Countrywide's home-loan bank borrowings to $51.1 billion as of Sept. 30 from $28.8 billion three months earlier might "pose a risk to the safety and soundness of the FHLB system as a whole."

Countrywide already was near a cap on the amount of FHLB borrowings it could obtain under rules that limit those to 50% of assets held by the borrower. Ordinarily, FHLB borrowings equal no more than about 15% to 25% of a bank's assets, a former bank regulator says, and much higher levels would tend to make regulators jittery. Sen. Schumer says Countrywide now has reduced its FHLB borrowings by about $4 billion. The next quarterly disclosures on those borrowings are due in late March.

A spokesman for Countrywide says the FHLB borrowings declined "primarily because of growth in customer deposits, which reduced our need" for funding from the home-loan banks. "This decline was not driven by any action taken by the FHLB of Atlanta," the spokesman says.

A boom in the use of derivatives is giving creditors strong incentives to push troubled companies into bankruptcy rather than help rescue them, according to new research and industry experts.

A study by academics Henry Hu and Bernard Black concludes that, thanks to explosive growth in credit derivatives, debt-holders such as banks and hedge funds have often more to gain if companies fail than if they survive. The study suggests this development could endanger the stability of the financial system.

The findings highlight a crucial problem in corporate restructuring when more and more companies are facing financial difficulties as a result of the credit crunch and US economic slowdown. According to the research and industry practitioners, creditors have a strong interest in voting against a restructuring plan if they have bought credit or loan default swaps, which trigger payments when a company fails.

“Investors now accumulate positions in a company by targeting layers of debt or multiple layers of debt,” said Michael Reilly of the financing restructuring practice at Bingham McCutchen.

“Where their interests lie are less predictable, especially if they also hold credit default swaps. Their financial interests may be best served by forcing a default if they are on the right side of a CDS position.” The problem is compounded by creditors not having to disclose derivatives positions, making it very difficult for companies and regulators to find out their real intentions.

The intensifying credit crunch is so severe that lower interest rates alone will not be enough “to get out of the turmoil we are in”, Dominique Strauss-Kahn, the managing director of the International Monetary Fund, warned at the weekend.

In a dramatic volte face for an international body that as recently as the autumn called for “continued fiscal consolidation” in the US, Dominique Strauss-Kahn, the new IMF head, gave a green light for the proposed US fiscal stimulus package and called for other countries to follow suit. “I don’t think we would get rid of the crisis with just monetary tools,” he said, adding “a new fiscal policy is probably today an accurate way to answer the crisis”.

Mr Strauss-Kahn’s words rip apart a long-standing global consensus that fiscal retrenchment in the US and Japan is needed to help reduce huge trade imbalances. It comes as the IMF is due to release new economic forecasts this week which, he said, would show a “serious slowdown and it needs a serious response”.

Within minutes of last week’s rate cut by the Federal Reserve , market analysts predicted that the European Central Bank would have to do the same. When the US sneezes – you know the rest.

It is not going to happen. The ECB may cut interest rates at some point, though I would not bet any hard currency on this. One of the most important reasons historically for monetary union in Europe was to become less dependent on the US. Today, monetary policy in Europe is geared towards domestic targets. If the ECB cuts, it will happen because of firm evidence of a fall in domestic inflationary pressures.

Some central bankers have even advocated a rate increase. If there is concrete evidence that the most recent spike in headline inflation rates is translating into higher wages, that may still happen. Most probably it will not. But the prospect of a rate cut is just as remote.

The number of foreclosures filed by US homeowners increased sharply in December and left calendar-year 2007 foreclosures higher by nearly 1 mln compared with 2006, according to a private sector report released today.

The number of foreclosure filings for December was 215,749, up 6.8 pct from November, according to California-based RealtyTrac.

December foreclosure filings are 97 pct higher than the number of foreclosures seen in December 2006.

This rise led to a total of 2.2 mln foreclosures in 2007, up 75 pct from the roughly 1.26 mln the company reported in 2006. RealtyTrac said 1 pct of all US households was in 'some stage of foreclosure' in 2007, up from 0.58 pct in 2006.

Ilargi: You may have noticed that we have so far ignored the SocGen rogue trader story. That's because we never felt till now that the real story was out in the open. Now, however, we're getting somewhere: French magistrates have refused to keep Jerôme Kerviel in custody, and haven't even charged him with anything (contrary to what many news sources claim). The government is chiming in as well, and the directors have hot feet. SocGen is in deep trouble.

French prosecutors will not appeal against a decision to throw out the accusation of fraud leveled against a trader blamed for huge losses at Societe Generale, a senior judicial source said on Tuesday.

If confirmed, the move would represent a blow for SocGen managers, who last week branded trader Jerome Kerviel a "fraudster" and said the bank had been the victim of "massive fraud". The judicial source said it was also "inevitable" that many staff within SocGen would be questioned over the affair.

Investigating judges reviewing the case decided on Monday to place Kerviel under formal investigation for lesser allegations concerning breach of trust, computer abuse and falsification, which carry a maximum three-year prison term. Being placed under investigation can lead to trial, but falls short of filing formal charges.

Prosecutors had asked the magistrates also to consider charges of fraud and "aggravated breach of trust", which carries a maximum seven-year prison term. Judges Renaud Van Ruymbeke and Francoise Desset decided there was not enough evidence to back this up. They also rejected a request by prosecutors that Kerviel remain in custody as investigations continue.

Société Générale is facing legal action from shareholders claiming the bank is involved in insider dealing as today it emerged that a non-executive director at the French bank sold off nearly €100 million worth of SocGen shares eight days before the discovery of "irregular trades" made by "rogue trader" Jérôme Kerviel.

Documents released by the AMF, the French market regulator, show that Robert A. Day, an non-executive director at Société Générale, sold off €85.7 million in shares on January 10. Also, two trusts connected to Mr Day, offloaded large chucks of shares on the same day - the Robert A. Day Foundation sold €8.6 million in stock and the Kelly Day Foundation sold €959,066. Details of the share sales emerged as Mr Kerviel was charged with attempted fraud by the French financial police.

Paris prosecutor Jean-Claude Marin said that Mr Kerviel has admitted hacking into computers and faking e-mails to hide trades since 2005.

Mr Kerviel also disclosed that Eurex, the derivatives exchange controlled by the German stock exchange, contacted Société Générale in November 2007 to flag up Mr Kerviel's trades with France's second largest bank - two months before the irregular trades were fully investigated and announced to the market. Mr Marin said: “Questioned by the bank, [Mr Kerviel] produced a fake document to justify the risk cover."

A group of around 100 Société Générale investors have brought a suit against the bank. Mr Day, 65, is the founder of TCW, a Los Angeles investment company which is a subsidiary of Société Générale's asset management group. TCW, based in Los Angeles, has a portfolio of $66 billion in collateralised debt obligations (CDOs) of which $52 billion are under management for Société Générale Asset Management.

CDOs are complex financial instruments which are often backed by sub-prime mortgage debt. Société Générale revealed last week it has €4.9 billion in CDOs backed by US sub-prime mortgage debt.

Today Citigroup cut the bank's possible target price by 50 per cent, saying the French bank is suffering "damaged credibility" and is unlikely to be taken over. Citigroup, which downgraded the scandal-hit French bank’s shares from a "buy" to a "sell" also cut its target price from €130 per share to €65, reducing its market price tag from €72.9 billion to €36.4 billion.

I only partially understand these things, but I don't really understand why Ilargi is so confident that we'll get deflation rather than hyper-inflation.

Surely lots of the money supply is going to be written off as bad debt over the next few years which will have a powerful deflationary effects. Surely lots of entities will try to counter-balance this, with whatever economic levers they can muster: bizarre financial instruments, the militaries new "allowance" (pay us now and we'll put it on our balance sheet in 09), lowering interest rates, hell probably even seignorage.

But then isn't there a danger that the attempts to counter-balance will overcorrect and shoot us into hyperinflation instead? Aren't hyper-inflation and depression always dual risks occuring together when people try to control the macroeconomy?

Presumably IF (hypothetically) a cabal of kleptocrats controlled the macroeconomic levers, their goal would be to suck as much value as possible from the system, and then before it was too late convert it to something stable, and send the system into massive depression (relative to their relatively stable security), so that their securities would have as much buying power as possible after they have taken what they can get.

But at the same time, anyone watching is getting suspicious of the shenanigans and suspicious of the long-term values of the instruments being used. The currency of the the country the kleptocrats are pillaging should be losing value relative to any form of genuine wealth. But if it loses enough value, but the poor plebes are forced to use it anyway (rather than just switching to some other currency), it should hyper-inflate right?

The kleptocrats are caught between two competing goals, they want to extract as much value as possible from their host, but they also want to escape with the loot and convert into something stable. So they have to make the host's currency look valuable, until they have done all the trades and escaped. But then presumably, when they can hide the damage no longer people react by radically lowering their estimations of the value of the host's financial instruments, whether that be dollars, or CDOs, or rubles, or whatever. And perhaps they are angry at or scared of the cabal that did it too.

It seems like a market collapse, is always a 3 sided battle: some folk in debt positions want to inflate their way out of debt. Some folk in credit positions, want their securities to retain or even appreciate in value. Some folk have good incomes, live off dividents or wages or what not, and want the system to remain functional and stable. But if those stabilizers get scared enough of depression they might align with the many debtors looking for a way out and open the floodgates just a little too far, and get hyper-inflation, right?

I can't answer your question but have wondered about that myself since reading about the FDIC issue. My fears go a step beyond the insurance issue and more toward the delay and inconvenience if ever a major bank in Canada became suspect. I believe that, just like Britons standing outside Northern Rock branches, we too would queue for the bank run. Who knows how long it would take until you actually saw money to spend.

Right now the money I direct is short but, at some point, I'll either lose most of it or have a large paper gain. But at that point, the reason I will have made money is the same reason that means all of those gains are at risk of not being accessible. Si I'll want to cash out somehow. But having 10's of thousands in paper bills in the 'Bank of Sealy' isn't attractive.

I'll get to the point: the best vehicle I can think of getting into in terms of safety and convenience is Canada Savings Bonds, cashable at whatever financial institution happens to be open at the time.

Anyone please feel free to suggest other alternatives that are safer and more convenient.

(Of course, CSBs would also be a temporary thing. My goal is to buy a peice of land in a suitable community and stop thinking about money all the time!!)

Look this money/credit cycle spin certain seems right in its main points, but it seems to only be talking about minor resets that don't cut very deep.

It claims "Creditors will end up with all the assets that are pledged on debts that default. Debtors will end up broke." But if things are mildly bad, the assets aren't enough to cover the debts, and the creditors have to fight among themselves for them. This assumes that the creditors have accurately assessed risk and the actual worth of the assets of the debtor used as securities. But if there is enough un-transparency, everyone can get hosed, creditor and debtor alike.

If there has been enough smoke and mirrors, maybe the assets aren't close to enough for the debts. Indeed, if it gets a little worse, the regular rule of law breaks down and creditors have trouble actually extracting the assets from the debtors. The debtors gang up politically, or go to ground. Or the politicians change the laws. Or obscure laws already on the books start coming into play. Or the courts get clogged enough that people start settling. Or the neighborhood moves the family back into the house after the goons have evicted them, and start getting guns and watch schedules. Or the assets are only in fact valuable together with other conditions that no longer apply, so the creditor and debtor both get screwed. Or the whole fabric of the society in question unravels enough that the assets devalue. Or it comes to mafiosos and revolutionaries.

But when things get bad, people stop trusting in money and banks, and denominate debts and credit in family relationships, favors traded, social obligations, and other personal exchange pledges rather than risking the money/debt market. But a personal debt of honor to someone you personally trust, or personally feel obligated to, that creates a non-money-like, non-fungible store of value, right? The social capital system creates a barely-fungible off-the-books re-flation. That's how the Russians got through the 90s, while there assets were stripped, and their currency devalued and revalued erratically.

The government fights hyper-inflation as long as it can, because it is essentially throwing in the towel. The Japanese even managed to avoid it entirely. Hyper-inflation pisses off the banks, the manufactures, etc. But if everything has fallen apart anyway, and the creditors have taken their assets and left, those who are left behind want to really reset the system. Or contrarywise, if the Kleptocrats stay and try to run things, the people may rebel or obey out of fear, but will move as much of value as they can off-the-books to other forms of exchange other than the money/credit system that the kleptocrats now own. Hyper-inflation resets the monetary system too, doesn't it? In fact, if the people don't have enough money to spend to get things done, new institutions will always start issuing some kind of IOUs, even if just at the local level, and as the old currencies become out-dated they'll hyper-inflate. So when things break down enough, they will try to reset one way or the other.

But it still seems optimistic to think that monetary resets will always be deflations rather than switching currencies (often to non-money-like currencies).

But maybe I am still not understanding. This is all very murky, and frankly contested water.-Brian M.

Even though the law states that bank depositors are not first in line when the FDIC steps in to bail out a failed bank, I cannot imagine what financial mayhem would ensue if word got out that an FDIC-insured account was not made whole. I have to think the money would be found SOMEHOW, just to avoid social meltdown. But maybe even the gov't has lines it cannot cross - that's the part I'm having trouble wrapping my head around.

And if the superlien story is true, how would this play out? If my bank has borrowed 15% of its assets from the FHLB, could I assume in a meltdown that my savings account would take a 15% haircut?

BTW, ilargi, Stoneleigh, it's good to see you back again. For a layman trying to decipher how the world economy functions, it's a life saver.

To get hyperinflation, you need a hyper increase in money supply. Someone printed those million mark bills in Weimar. Where would you see that coming from today?

What I see is the opposite coming up: a hyper decrease in money/credit/debt supply, from the values of real assets like homes, spiraling all up and down the Ponzi pyramid into the derivative instruments that have been shoddily constructed using these values as a foundation.

The average home in the US, and Canada for that matter, is "worth" twice as much as 10 years ago. Why? Really great paint job? No, inflation.

We've had the inflation, and never saw it, because bread had the same price, while we thought our homes were gaining in real value.

Now the homes are on their way back to their true real value, as in what they were worth in 1995, and all the finance structures deflate with them. Many of them will deflate to zero, the only value they ever had was built on the presumption that the home's value, or some other asset's value, would keep on rising. That is Ponzi, after all.

I tell you that of you give me $10, I'll give you back $11 next week. I keep my promise. How? I tell your neighbor the same thing the next day, and he gives me $10 as well. I owe him $11, but one day later than I owe you, so $1 of his goes to pay you the interest I promised. Works like a charm. Long as there's enough neighbors.

But: I never had any assets!!

Trillions of dollars will disappear as if they never existed, they were not based on any real underlying asset. It was all only leverage, all the time. Since no central bank can print $10 or $100 trillion, deflation is the only possible outcome.

Resets can happen at various scales, and the severity of the hangover is generally proportional to the scale of the party that preceded it. I think what's coming is a reset on a very large scale, like the 1930s only worse. We've seen a derivatives market go from nothing to a notional value of about $750 trillion in about 25 years - now that's a credit expansion!

You're right of course that a large enough reset ruins both debtors and creditors, precisely because much of the money supply disappears into thin air (deflation).

Whereas currency inflations result in the real wealth pie being cut into smaller and smaller pieces - a form of forced loss sharing - credit expansions create multiple and mutually exclusive claims to the same pieces of real wealth pie. As the expansion morphs into contraction, the fight between claimants begins, and much real wealth (in addition to the illusory value of credit) is destroyed.

One More Thing.From -http://globaleconomicanalysis.blogspot.com/2008/01/bank-reserves-go-negative.html

Bank Reserves Go Negative

"Given that the Fed is not in a credit tightening mode, we must look for a better explanation. Here it is: Banks in aggregate have now burnt through all of their capital and are forced to borrow reserves from the Fed in order to keep lending"

One Boo-Boo Mish stated -"I cannot stress this enough: If you accept these offers, please make sure you never go above the FDIC limit."GOOD LUCK.

I'm still confused re: inflation and deflation. It seems too easy for a gov't to inflate its currency to me. Money is borrowed into existence, and the biggest debtor (the gov't) is potentially able to borrow near-infinite amounts. The tax rebate is an example of this. I realize that housing prices are driving the economy in a deflationary direction tho.

I guess it really doesn't matter much if the end result is a currency worth exactly what it is printed on.

Trillions of dollars will disappear as if they never existed, they were not based on any real underlying asset. It was all only leverage, all the time. Since no central bank can print $10 or $100 trillion, deflation is the only possible outcome.

Why would they need to 'print' $$, when most exchange these days is in digi-dollars? Is it these digi-dollars that 'will disappear'?

Look if our homes only go back to 1995 prices then we will have a normal deflation and Ilargi will be right. But 750 Trillion$, thats what the world's GDP for 25 years? Thats insane. And that's just derivatives. The notional money supply has no relation whatsoever to underlying wealth. More than enough money for hyperinflation in consumer-goods prices has already been electronically created. Heck half of the existing nominal money supply could evaporate, and you'd STILL have enough money supply left for consumer goods to hyper-inflate.

When things deflate enough, normal folk won't be able to function and then they'll switch to a different currency to function, even a non-monetary currency. Indeed, if it gets bad enough that the government can't function, it will print the money again to function, EVEN THOUGH IT KNOWS FULL WELL, that this won't create wealth, and is just Zimbabwe economics. That's what desperate governments do. It wasn't Hilter that caused Germany's hyper-inflation it was the Weimar folks.

Further, you don't need to create new money for hyper-inflation, you only need your existing money to lose enough value. When the dollar drops low enough, no one will use it for normal transactions, the only thing it will be good for is paying off old dollar denominated debts. And most dollar denominated debts will have been written off during the deflationary segment of the problems. Look if you imagine severe deflation in the near future, what do you imagine happening next? If everything goes back to buisness as normal, you get re-flation and then more normal growth. But if the deflation wrecks the system, inhibits wealth creation, or coincides with changings in the underlying fundementals (like say oil having peaked), then after a severe deflation, you should have a variety of disaster coping-scenarios until some new normal can emerge, right?

Maybe we are also disagreeing on the definition of inflation. Some people mean growth in the money supply (er and which money supply exactly), some people mean increase in the price of some basket of goods (which goods exactly?). Usually these go together well, but you can technically have decreasing money supply together with increasing cost of goods, if people are getting overall poorer fast enough, as for example, when the system is dysfunctional enough to put people in lose-lose situations, where even creditors are losing in a deflation.If an ever shrinking segment of the global wealth pie is pegged to dollars, then dollar denominated prices can hyper-inflate even while the dollar volume is shrinking, right?

In fact I'll go one step further. If the creditors have given credit without sufficient collateral (say they were betting on growth), what they want is as few defaults as possible, but to live on the interest, even if they never get the full principle back. So if a mass of defaults looms, the creditors and debtors will both loose their shirts, so they can conspire to inflate prices (and wages). This means that the debtors are more likely to pay back SOME of the debt (and keep paying those interest installments...), rather than defaulting entirely, at the cost of decreasing the actual value of the principle. Just like the Saudi's forcing sea water into the wells, decreasing the overall lifetime yeild, but increasing the short term flows.

If the creditors can seize sufficient assets to cover things, they WANT the debtors to default, but as soon as they realize that there just aren't sufficient assets there anymore (like oh say, the assets used as collateral were devalued houses, or the assets were smoke and mirrors accounting tricks in the first place, or the assets were based on unenforcable contracts, or they just didn't ask for enough collateral in the first place, etc.), they want to string the debtors along to pay off as much as possible. If a large percentage of the economy is threating default in the near-term, it sure seems like many parties have an interest in promoting inflation, including even the creditors trying to cover their own dumb lending.-Brian M.

While I agree that credit contraction, over valued assets resetting, and writing off debts are all deflationary threats, and from the perspective of CB levers are hard to control, especially as public sentiment to spend sours.

Yet on the other hand I also do think that this outlook almost completely overlooks the abilities and propensity of governments dealing with such a scenario to take on the mantle of fanning inflation via a lot more deficit spending. As it is the base infrastructure of the US is in deperate need of rebuilding and I think we can all readily imagine that our politicians will want to be seen as doing whatever it is they can to reinvigorate the economy with all manner of reinvestment policies.

None of this will happen smoothly as our standard of living resets in the process and the dollar continues its decline against real and imported goods. What it all suggests to me is that we can have private sector credit contraction and asset value deflation along with currency devaluation inflation via government intervention policies of massive deficit spending.

I think the rebate stimulus package is just the begining of what is to come after the election.

I wouldn't know if the govt has a stomach for a new New Deal bubble, but how about a WWIII bubble, WWII seemed to work a treat for the last depression, but of course that was after things unwound. But then again, if we beat the unwinding by not waiting for spring but having it now, who knows where we could send the world economy, maybe to the moon along with large chunks of the planet?:)